The wisdom of private debt crowdfunding

Since online crowdfunding commercial real estate platforms began popping up in 2012, they have been treated as something of a novelty by the mainstream industry. 

But as the size and number of crowdfunded real estate deals increases and new regulations open the door to more 'crowd' investors, some believe crowdfunding will become a standard bearer in the market.

“For us and our industry, it's going to look crazy; five years ago there wasn't any way for regular investors to invest in real estate,” says Charles Clinton, chief executive of EquityMultiple, a relative newcomer to the crowdfunding scene, launched in September. 

As a real estate lawyer whose main client was Blackstone, Clinton saw himself doing something more entrepreneurial than private lending, he told PDI's sister title Real Estate Capital recently.

He saw the need for more opportunities for small lenders while he was working for one of the largest investors in the world. “Even I didn't have any access to the market,” he says. “Maybe enough to flip a brownstone in Brooklyn.” 

His entrepreneurial interest was piqued further when Congress passed the Jumpstart Our Business Startups (JOBS) Act in 2012, which allowed an exemption to a previous ban on the public solicitation of private capital investment. Crowdfunders could now advertise broadly and solicit funds from accredited individuals with a net worth of $1 million and/or an annual income of $200,000. 

The act set off a wave of over 100 crowdfunding platforms that connect individual and institutional investors to pre-vetted equity and debt investments offered online, many of them bringing onboard industry heads from traditional lending platforms.

Clinton helped launch EquityMultiple in partnership with existing real estate firm Mission Capital, with the intention of opening the doors to investors who did not have an 'in' to the exclusive club of real estate financing. 

Accredited investors are required to make a minimum investment of $5,000 for equity or debt investments. 

By September 2015, the total capital raised for real estate development and investment in the US through crowdfunding reached $208 million, according to Crowdnetic, an industry research firm. 

But by last June the crowdfunding platform Realty Mogul blew the lid off of that figure when it announced it had raised $250 million for commercial real estate debt investments – pooled from a group of pension funds and an investment manager – to fund bridge and senior loans as large as $25 million against most property types across the US. 

Clinton said his company has completed its first debt deal, a $3.4 million pre-development loan on a project in San Francisco, and plans to increase its debt investments in the near future, as groups like Fundrise, RealtyMogul and Sharestates trek further into the debt lending space.

Daniel Miller, co-founder and president of Fundrise, said last summer that the success of debt crowdfunding capitalises on the areas that have been largely ignored by mainstream lenders and suggested that urban infill locations driven by middle market real estate investors are the niche that will allow crowdfunding to become a CRE mainstay.

Miller suggested that Fundrise's lending platform was born from “frustration with traditional groups that would not do deals smaller than $30 million or $40 million”. But by last November, RealtyMogul once again broke out of that range and closed a $49 million bridge loan to fund the acquisition of an apartment complex in suburban Atlanta, the largest to come out of the crowdfunding space. 

Not only has the size of deals done through crowdfunding increased, but looser regulations may allow these platforms to draw from an even bigger pool of non-traditional investors. Last autumn, the Securities and Exchange Commission (SEC) implemented a new rule that allows non-accredited investors to participate in equity crowdfunding as well. It may be just a matter of time before this is allowed on the debt side, too.

Some in the real estate industry fear that allowing non-accredited investors to use crowdfunding platforms is too risky due to their smaller incomes and informational disadvantage. Clinton says his company has no intention of taking money from non-accredited investors anytime soon. 

“We don't want to feel like we are taking money from people who don't know about investing in real estate,” he says. 

Allen Shayanfekr is co-founder and principal of another CRE crowdfunding newcomer. Sharestates requires a minimum $1,000 investment but has also been one of the few crowdfunding platforms to take money from non-accredited individuals. 

“We are trying to keep it as accessible as we can, but that might not be possible,” says Shayanfekr. 

Both Clinton and Shayanfekr argue that crowdfunding platforms are more transparent and less vulnerable to market volatility than public REITs, as well as being the only other way for a novice real estate investor to get involved in the market.

Another perk is avoiding the broker fee. “Brokers on traditional deals get a huge payload to push investors into deals they may not be able to afford, but when you compare that to us or people in our industry it's light years away from what we charge,” says Clinton.

Both men add that crowdfunding allows a small investor to know exactly the property being invested in, while a REIT pools the investor's money so that it's impossible to see. But the most meaningful difference between crowdfunding and REITs, Clinton argues, is that crowdfunding makes investments less subject to REITs' stock market-like volatility – especially that of public REITs. 

Shayanfekr adds that the other issue in REITs is that the going rate of return is 8 percent, while his platform offers 10-12 percent net returns, which is typical for the crowdfunding space.

But Joseph Pagliari, real estate professor at the University of Chicago business school and former consultant for Blackrock, isn't buying that argument.

“The argument of volatility of public REITs is a bit of 'straw man' argument,” says Pagliari, arguing that although public REITs are subject to stock market volatility they generally perform well over the long-term.

REITs offer a diversified portfolio of properties with experienced management teams, a strong balance sheet, SEC reporting and Wall Street analysis for maximum liquidity. Crowdfunding does not.

Clinton says that there's a perception that crowdfunded money is 'dumb money', but that isn't so. 

Admittedly, non-accredited investment may be dangerous, due to the potential risk of lost profit and abuse, he says. But a safer way to grow could be to add institutional investments into the mix alongside accredited investors to increase dealflow. 

He adds that while many of the hundred or so crowdfunding sites are doing a good job, there's going to be many who will act irresponsibly. 

“There always will be people who try to sell snake oil,” he says.